Funny money

Commercial banks grant credit to their customers, big and small. But they only possess a tiny fraction of the money they lend, as little as 3%. The rest only exists in writing. It is scriptural money based on promises of future reimbursements. However, it is accepted as payment and circulates as such. At term these debts are either renewed for another period, or they are paid back, often in instalments. In the second case they are lent out again to other customers. What distinguishes payments is that some are made with past incomes while the others are made with future incomes that have not yet materialised. Credit and debt are bets that future revenues will be available. And the risk of such a wager justifies the extortion of interest. Defaults on debt do occur, and lenders write them off as calculated losses. Problems arise when the numbers of defaults is greater than expected, when they come in large clusters. If they pass a certain percentage, they cancel the profits of interest. Beyond that they consume the banks reserves and bankruptcy looms.

Credit comes from nowhere by writing, but it can only return to oblivion when future incomes materialise. It is and then is no more, as it has already been spent. However, credit can be and is prolonged indefinitely by being granted a new term or transferred to another borrower. This perpetual credit accumulates as additional ones are constantly being granted. Credit expands and reaches a point where the solvency of new borrowers is questionable. The mass of people whose future incomes are uncertain, and whose only source of credit used to be the pawnbroker and the payday lender, are encouraged to buy all they need or want and pay later. Subprime lending and junk bonds are attractive because they pay much higher rates of interest. This high interest comes with a heightened risk of default. But all those capital profits must be invested somewhere, either as company shares or in debt. And capital gains need to be as large as possible.

Bad debts are statistical probabilities. But they can be overwhelming. This can happen when there is overreach, when the vast volume of debts risks toppling at the slightest incident. A dozen years ago mortgages on inflated house prices had been granted far and wide, and the demand they generated pushed prices even higher. This created a perfect bubble that brought down Lehman Brothers and threatened global finance. The system was saved by floods of cash from central banks, and lending took off again to ever loftier heights. Bond buying by central banks was on such a gigantic scale that it pushed up their prices and brought interest down to almost nothing, and even lower. This led to a surge in debt funded acquisitions and share buybacks, but households and consumers went on being bled for their mortgages and overdrafts.

By the end of last year all kinds of debts, from governments to students, had reached alarming levels. Then came the COVID pandemic and the overburdened structure began to slowly fall apart. Central banks and governments seem to think that more of the same will solve the problem. But today’s crisis is not just about debt. It includes closed businesses and industrial sites, rent arrears and consumption falling off a cliff. Throwing cash at it will not save the situation this time. Whereas debt cancellation, democracy in work-places and a massive redistribution of income would solve a lot of things, and drastic cuts in carbon dioxide emissions would have to be part of the solution. None of this is likely, as most people seem to want to go back to where they were three months ago. The known is often preferred to the unknown, and this conservative preference is the ruling class’s main ideological foundation. What is was and will be, as there is no alternative.

Capitalism’s necessary expansion was already in trouble before the pandemic. The present contraction is so sudden and massive that the debt structure based on growth will probably collapse as defaults multiply. As usual, governments will pretend they have things under control, until they manifestly do not and resort to a state of emergency and martial law. The system was wobbling and is now broken beyond repair. Will something new emerge, or will the same old violence and oppression just accelerate their devastation?